After years of struggling to reduce high unemployment, the Federal Reserve is grappling with another tough challenge: how to raise very low inflation.
So far, the Fed has had more success with the unemployment rate, which has fallen more than a percentage point, to 7 percent, since the Fed launched its bond-buying program last year. But inflation has declined since then, and it remains far below the Fed’s 2 percent target. Fed policymakers expect inflation to remain below the target through at least 2015.
“There is still this question about inflation, which is more than a bit of a concern,” Chairman Ben Bernanke said at a news conference Wednesday. The Fed “is determined to avoid inflation that is too low, as well as inflation that is too high.”
Most Americans likely prefer lower inflation when they pick up groceries or shop at the mall. But Bernanke and many other economists worry that if inflation falls too low, it would lead consumers and businesses to delay spending. That’s because shoppers feel less pressure to rush their purchases if prices aren’t rising much. Some items, such as clothing, furniture and certain electronics, have become less expensive in the past year.
Very low inflation also makes debts comparatively more expensive to pay off.
The Fed decided Wednesday to cut its monthly bond purchases to $75 billion from $85 billion, starting in January. Bernanke suggested that the purchases could end by late next year. That’s evidence that the Fed thinks the job market and economy will continue to improve with less help from the Fed.
But if inflation remains too low, Bernanke said the Fed might decide to keep short-term interest rates near zero for a longer period or take other steps to try to boost inflation.
“It’s difficult to get inflation to move quickly to target,” he said.
Too-low inflation also raises the threat of deflation, a debilitating drop in prices that can cause a recession. When prices fall, spending slows sharply, as consumers and businesses stop spending to await better deals.
By contrast, higher inflation can help Americans pay their debts. In part, that’s because loans remain fixed in value, while inflation can raise wages.
Fed policymakers forecast that inflation will rise by barely 1 percent this year, according to the latest quarterly projections released Wednesday. It will only rise by 1.4 percent to 1.6 percent in 2014, the Fed predicts.
The Fed expects unemployment to fall as low as 6.3 percent next year and 5.8 percent in 2015. Both are one-tenth of a percentage point lower than it forecast in September. Unemployment has fallen faster this year than policymakers had predicted.
The Fed estimates that economic growth will be between 2.8 percent and 3.2 percent next year, roughly what it predicted in September. Growth for 2013 will likely be about 2 percent.
Fed policymakers have said they’ll keep the short-term rate they control near zero at least until unemployment falls below 6.5 percent.